Secular Stagnation In The U.S. May Not Be So Secular After All, Academic Panelists Say

Written By: Paul Sheard, Beth Ann Bovino and Erkan Erturk
Written by Paul Sheard, Beth Ann Bovino and Erkan Erturk

The U.S. economy's historically muted recovery from the Great Recession, and associated low short- and long-term interest rates, has lent credence to the idea that the country is mired in so-called "secular stagnation"--a prolonged period of sluggish GDP growth and low interest rates resulting from permanently weakened or altered fundamental factors. But is the world's biggest economy actually suffering such a fate?

Technically, secular stagnation refers to a situation where the so-called "natural rate of interest" or "Wicksellian rate of interest" is more or less permanently negative, or at least very low. This is the real (as opposed to nominal) rate of interest that equates the supply of savings (measured in GDP or national accounting terms) with the demand for savings, which is none other than the demand for investment. A negative or very low natural rate of interest could reflect savings being "too high" or investment being "too low." And such a situation could be due to "temporary" factors whose effects will eventually dissipate, or permanent ones that reflect structural features of the economy.

Panelists who participated in S&P Global's most recent Academic Council acknowledged that growth is clearly below trend and will likely stay that way for some time. While evidence exists to support both sides of the temporary-versus-permanent argument, many panelists attributed the slow growth and low interest rate environment more to the lingering effects of the recent financial crisis than any secular (long-term and of indefinite duration) changes to the elements that underpin economic expansion.

To be sure, there are signs that factors related to lower potential output, and changing savings and investment preferences, are putting downward pressure on U.S. equilibrium interest rates. In this light, S&P Global expects long-term borrowing costs to remain lower over the next decade than they were, on average, in the two decades leading up to the Great Recession. Additionally, other experts suggest that factors that may have started out as temporary have become permanent, potentially bringing about "hysteresis," or the process through which low resource utilization leads to persistent weaker productive potential.

Against this backdrop, one council member pointed to the fact that, in the four expansionary periods of the past 35 years, each has been slower than the last--with the 4.3% average GDP growth of 1983-1990 slipping to 3.6% in 1991-2001, to just 2.8% in 2002-2007, and to a mere 2.2% from 2009 until now. S&P Global agrees that the decline in long-term interest rates in the U.S. (and globally, for that matter) over the last quarter of a century reflects a number of both long-lived and transitory macroeconomic conditions. But stagnation is a relative term: Real GDP in the U.S. is "only" 11% above its precrisis peak (while in a "normal" recovery that figure would be roughly 15%-20%), the eurozone economy is just 1% larger than before the downturn, and Japan's is essentially flat.

Meanwhile, the U.S. is approaching full employment, with headline unemployment hovering around 5%--half of what it was during the depths of the recession (with the caveat that the broader U6 measure of unemployment is still somewhat elevated and the very low labor-force participation is masking some weakness in the jobs market). And workers' bargaining power has, at long last, begun to strengthen, with wages rising.

Still, most economists think investment levels are lower than where they ought to be, one council member said. But even with the U.S. savings rate in the 5%-6% range (higher than before the crisis) this isn't necessarily a bad thing, given what happened in the run-up to the Great Recession, with many Americans taking on far more debt than they could ever hope to pay off. As such, reversing the current trend might not be the best solution to the perceived problem of too-low investment. Moreover, the massive shift in the credit supply related to the housing boom that preceded the worst economic slump since the Great Depression suggests that the slow growth we're seeing now isn't secular.

One council member said that interest rates were, instead, acting cyclically--over a long cycle, surely, but in a cycle nonetheless because of the "deep scars" left by the financial crisis. At the same time, high income inequality and wealth concentration are contributing to low growth. This is because the more affluent typically spend less, proportionally, of what they earn than those at the lower end of the income ladder do. In the simplest terms, with more money going to top earners, less is finding its way back into the economy. This inequality (which, to be fair, has lessened somewhat recently) didn't curb growth in the years before the crisis because of the massive quantities of debt less affluent Americans were taking on.

At any rate, even if the U.S. isn't stuck in the swamp of secular stagnation, there is a sense among many economists that there may be a new equilibrium for growth and interest rates, one council member said. Additionally, there are significant "tail risks" that economists and policymakers need to keep an eye on. Just as the severity of the recent crisis (including what was essentially a run on U.S. banks) was largely unimaginable, so could the next shock be outside the realm of rational expectations.

In this context, it's important to be careful with regard to terminology when we assess the current state--and the potential--of the U.S. economy. Part of the problem, one council member said, is that many economists are too focused simply on the question of whether or not the economy is suffering from secular stagnation. It would be better, he said, to refer to sluggish growth as being either supply-driven or demand-driven.

Either way, the current environment has clear ramifications for investors, who will need to adjust their expectations and plan for more modest returns than they could reasonably have expected in the past, one council member said.

More important, perhaps, are the potential implications for Federal Reserve policymakers. The risk here is that the U.S. could fall into a recession that would be very difficult to get out of, given the central bank's extremely limited room to move with regard to traditional monetary policy. With the federal funds rate at just 0.25%-0.5% (with futures markets betting on a quarter-point increase next month) policymakers won't be able to cut the benchmark rate by the four to five percentage points they typically have during previous recessions.

In the end, a surge in GDP growth would probably push the idea of secular stagnation, first raised in the late 1930s by Harvard economist Alvin Hansen, back into the "intellectual dustbin"--just as it was by the outbreak of World War II and ensuing postwar prosperity. On the other hand, continuing sluggishness in the economic recovery could make the revival of the debate by former Treasury Secretary Lawrence Summers particularly prescient.

Writer: Joe Maguire